New research from the University of Michigan shows that the trend toward market-based incentives to control pollution lowers the costs of pollution abatement for businesses, but may not achieve environmental goals. In some cases, said U-M researcher Gloria Helfand, market incentives actually make pollution problems worse.
"The Case for Markets Versus Standards for Pollution Policy," co-authored by Helfand, an associate professor of environmental economics at the U-M School of Natural Resources and Environment, and Peter Berck of the University of California at Berkeley, will appear later this month in the Natural Resource Journal. Examples of market-based incentive are pollution taxes, subsidies for abatement and marketable emissions permits. The other approach is to set standards, which simply sets a cap that cannot be exceeded. This is also called the command and control approach.
Market-based incentives have become more popular as a cost-effective way to cut pollution over inflexible environmental standards or pollution caps, but until now little analysis has been done on existing data to determine the effectiveness of the market approach, Helfand said. Businesses like them because they're less expensive and more flexible.
The findings, Helfand said, should serve as a warning to policy makers against assuming that market based incentives are the best solution. Rather, she said, market incentives should be chosen as policy on a case-by-case basis, because sometimes setting standards will better achieve environmental goals.
Researchers found that market-based incentives work well in areas with localized pollution where it doesn't matter who does the polluting. For instance, if the goal is to lower air pollution in a small area, it doesn't matter which polluter abates as long as the overall emissions are reduced. However, if the issue is about dumping in a river, then the pollution source does matter because some areas of the river could become much more damaged by heavy polluting than others.
"As long as you limit pollution it doesn't matter who cleans it up," Helfand said. "The big advantage in that situation is that it encourages more pollution reduction from sources where it's cheap to clean up, and it cuts slack for sources when it's very expensive to reduce pollution."
One example is the 1990 acid rain program, which combined a market-based approach with an overall emission cap of 50 percent. Companies who achieved cleanup inexpensively could sell so-called emission allowances to those who found cleanup cost prohibitive.
However, problems could arise if companies in one area---say the Midwest, which contributes to the Northeastern states' acid rain problem---found cleanup too expensive and snapped up all the pollution allowances.
Contrast that with an across-the-board cap, with companies required to reduce emissions a certain percentage. In this case, concentrating damages on one place is much less likely to happen.
"Market approaches may not work well when it matters who cleans up," she said. Helfand stressed that this did not happen in the acid rain program, but it could in other similar approaches.
Another problem with market-based incentives is that they only work with sufficient monitoring equipment in place and often that's difficult, she said. For market-based approaches, total emissions need to be measured; for pollution standards, in contrast, only occasional monitoring of the flows of emissions may be necessary. The difference between continuous monitoring and occasional monitoring may be costly.
This is problematic in developing countries, she said. In these situations, standards on emissions may be more enforceable than market approaches. Or, take the Kyoto Treaty with its potential for the trading of carbon dioxide allowances. Our ability to measure reductions in emissions, or "carbon sinks" that absorb greenhouse gases is still in its infancy. Standards that specify emissions rates or mandate use of a technology may be easier to enforce and lead to more certainty in emissions reductions than market approaches when measuring emissions is uncertain.
In situations where it doesn't matter environmentally who emits pollution, and where monitoring emissions is effective, market-based approaches can be very effective in reducing the costs of pollution abatement, she said. Because market-based approaches may not guarantee that environmental goals can be met, though, regulators should decide carefully whether their use is appropriate on a case-by-case basis, the study concludes.